After Applied’s Rocky Year Earnings Could Point To Its Recovery

With macro headwinds leading to soft demand for consumer products, most semiconductor manufacturers have reduced their capital spending, which in turn has led to a drastic decline in Applied Materials (NASDAQ:AMAT) equipment sales. Witnessing a more than 40% reduction in its semiconductor equipment sales, the company posted a 30% decline in its Q4 2012 revenue and registered a marginal decline in gross margins due to lower sales, inventory reserves and lower factory utilization.

Applied Materials will announce its Q1 2013 earnings on February 13. With a near 20% sequential decline in Q4 2012 orders, we estimate its revenue to continue declining in Q1 2013 as well. However, Applied believes that the orders bottomed out in Q4 and expects the situation to improve 2013 onwards.

Though the macro headwinds continue to suppress demand, we believe that the accelerated changes in device technology and the adoption of new materials in the industry will fuel top line growth for the company in the future.

Applied’s semiconductor manufacturing systems are used by integrated device manufacturers and foundries to build and package memory, logic and other types of chips. Weak market conditions have caused pullbacks in expansion plans throughout the industry as manufacturers adjust their production levels to match the end-user demand. With a significant fluctuation in demand, Applied’s silicon systems group was the worst hit in Q4 2012, with a 44% sequential decline across foundry, memory and logic customers.

While the wafer fab equipment (WFE) market saw spending increase by 13.3% in 2011, Gartner estimated the same to decline by 13.3%, totaling $31.4 billion in 2012. It expects capacity utilization to decline into the low 80% range before slowly increasing to about 87%. Though the situation is expected to improve in 2013, Gartner does not estimate the market to return to positive growth in the year. [1]

While weakness in the global PC market is the primary reason for declining investments, the robust growth in smartphones and tablets is driving innovation and could fuel demand in the coming quarters. Intense competition in the mobile market is leading to faster innovation, and the high demand of application processors is driving foundries to build out their 28-nanometer capacity and ramp investment for the 20-nanometer node.

Applied considers the above trends to be favorable as they create spending shifts that are favorable to its business. It forecasts the net sales for semiconductor business to be flat to up 10% in Q1 2013, and estimates orders to increase by 25% as customers increase capacity.

Solar Division Will Be A Long Term Growth Driver

Revenue from Applied’s Energy and Environmental Solutions (EES) division has declined drastically in the last year as the solar industry struggles with excess manufacturing capacity and soft end demand. While the company claims that the growth in demand is starting to consume the excess manufacturing capacity in the solar industry, it maintains a cautious approach as the investment in new capacity remains low.

Given the long term growth potential in the solar industry, we believe that the solar business could be an important long term growth driver for the company. While the slower than anticipated revival in the market has led to a significant decline in the market in 2012, we estimate the situation to stabilize in the future. (Read: Applied Could See A Turnaround In Solar Equipment Demand Next Year)

Having witnessed a steep decline in orders at the start of 2012, Applied announced a restructuring plan for its EES business in Q3 2012, to lower its cost structure and the operating breakeven level to approximately $500 million. As the demand in the solar industry remains sluggish, it plans to take additional steps to reduce its cost base and minimize the associated losses.

Smartphones And Tablets To Fuel Growth In Display Segment

Marking a 35% sequential decline in revenue, the display segment was probably at its weakest in Q4 2012 and Applied estimates net sales in Q1 2013 to be flat to down 30%. On the positive side, despite lower revenues, the display business remained profitable on account of increasing operational efficiency. Additionally, the mobility related business accounted for close to 80% of Applied’s display revenue in 2012.

With the current slowdown in growth of global PC shipments, the increasing adoption of smartphones and tablets is expected to fuel future growth in the semiconductor industry. The global appetite for mobile devices with new features, longer battery life and brighter, higher resolution displays continues to strengthen. As these devices drive demand for leading-edge foundry capacity, the market leaders are aggressively accelerating ramps at advanced nodes.

Applied Materials has a significant presence in the smartphone and tablet market. It expects to generate more than $250 million in revenue from products that serve new applications in this area in the future.

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